Flagship Communities Real Estate Investment Trust

Hello, ladies and gentlemen. Thank you for standing by. Welcome to the flagship community's REIT first quarter 2024 earnings call. At this time, all participants are in a listen-only mode. Following the presentation, we will hold a brief question and answer session for analysts and institutional investors. I would like to remind everyone that this conference call is being recorded. Today's presenters are Kurt Keeney, Flagships President and Chief Executive Officer, Nathan Smith, Chief Investment Officer, and Eddie Carlisle, Chief Financial Officer. Please note that comments made on today's call may contain forward-looking information, and this information, by its nature, is subject to risks and uncertainties. Actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings on CDAR. These documents are also available on Flagship's website at flagshipcommunities.com. Flagship has also prepared a corresponding PowerPoint presentation, which it encourages you to follow along with during this call. And now, I'll pass the call over to Kurt Keeney. Kurt?

Thank you, operator. Good morning, everyone. Thank you for joining us today.

The momentum we generated from 2023 has carried into the early part of 2024. Not only did we see improvements in rental revenue, net operating income, and same community metrics, but we have achieved many major milestones to start the year, and we expect these accomplishments to help to reach future growth. A high priority to begin this year was to refinance our near-term debt, to maintain our conservative low-cost debt profile, and we were able to do just that. We refinanced our near-term debt at a lower fixed rate, resetting our interest rates for another 10 years. The cash proceeds were also used to pay off existing debt. Now we have no substantial debt maturities until 2030. Completing these refinancings at significantly better terms helped improve our financial position and speaks to the confidence our lenders have in our business and the MHC industry. Most important, these refinancings helped pave the way for the largest acquisition in our history. We entered into an agreement to acquire seven MHCs, which expands our existing footprint in Tennessee and establishes a new presence in the West Virginia market, representing the eighth contiguous U.S. state where we operate. Nathan will elaborate during his remarks, but these acquisitions are the largest in our history and create an opportunity to become a market-leading owner by strategically expanding our footprint into adjacent and new markets, both of which enable us to maximize our existing synergies and leverage economies of scale. We first began operating in Tennessee in 2019 and have strengthened our presence in that state while entering Nashville, one of the hottest, fastest-growing markets in the U.S. We will also form a foothold in a new market, West Virginia, by establishing a presence in three distinct locations with five communities in that state. These were off-market transactions that represent a generational opportunity that position us well for future acquisitions. We remain confident in the underlying fundamentals of the MHC industry. Manufactured homes are a very appealing and low-cost effective option for many Americans. Our customers enjoy homes that are detached structures that do not share walls, utilities, air conditioning, or heating with any other homes. These homes include two, three, and four bedrooms, typically with two bathrooms. They also have a deck, yard, driveway, and in-home laundry facilities, all for less than the cost of renting an apartment. Providing affordable housing and an exceptional resident living experience is Flagship's corporate mission. And we recently published our fourth ESG report, which articulates our sustainability strategy and initiatives to help make that mission a reality for our residents. The report also outlines our commitments to our unit holders, employees, and communities through initiatives such as renewable energy, education, and household amenities. You also find details on our diversity programs and governance. Please visit our website to read the report and learn more about our ESG commitments. I will now turn it over to Nathan to provide more details on our recent acquisitions.

Nathan? Thanks, Kurt. Good morning, everyone.

Aside from expanding our presence in an existing area and entering a new US state, what makes these acquisitions especially significant is how they were sourced. These acquisitions are another example of the opportunity that we were able to source off-market through long-standing industry relationships. Sourcing acquisitions in this manner is an integral part of how we can add external opportunities to our portfolio. Kurt outlined some of the benefits of the acquisitions during his remarks, but let me provide a bit more context. These acquisitions enhance our size and scale. which increases our portfolio number of communities to over 80 and the number of manufactured housing lots to over 15,000. Expanding our presence in Tennessee, now we are in Nashville, one of the fastest growing cities in the United States and the state capital. We also entered West Virginia for the first time in flagship history in three distinct markets. In addition to being our eighth contiguous U.S. state, Where we operate, West Virginia is a market that understands manufactured housing and is very MHC friendly. These acquisitions have organic growth potential through our home sales strategy along with cost saving initiatives. And finally, we continue to expand our portfolio and are well positioned to realize the potential of a platform that continues to be scalable. We intend to continue our growth by sourcing acquisitions in existing and adjacent markets. Let me now describe the acquisitions in a little more detail. Beginning first with Tennessee, these acquisitions encompass two manufactured housing communities in our Nashville area. The first is in a Nashville neighborhood and has 300 home sites and is a value-add community. The community is 57% occupied and is well positioned with the ability to add amenities and implementing our growth strategy. The second community is in Murfreesboro, Tennessee, and it's best in class. It has 173 home sites and is located 35 miles south of downtown Nashville and is home to Middle Tennessee State University. The community is approximately 99% occupied and includes amenities such as basketball courts and a clubhouse. The West Virginia acquisition includes five manufactured housing communities in the state's largest metropolitan areas and is a value-add opportunity as well. The Morgantown acquisition includes two communities. The first has 187 lots and is 88% occupied. The other has 203 homesites and is 81% occupied. The Milton acquisition includes 213 homesites and is located 15 miles east of Huntington, West Virginia, which is home to Marshall State University. The community is 66% occupied and includes 21 rental homes, features many amenities, including a new playground, a clubhouse equipped with full kitchen and a billiards table. And the Beckley acquisition has two communities. The first has 120 home sites and is 87% occupied. The second community has 57 home sites and is 67% occupied. In our business, acquisition opportunities of these natures don't come along very often, and we look forward to implementing our home sales strategy in Nashville and West Virginia. Now I'll turn it over to Eddie, our CFO, to talk about our financial performance for the quarter.

Eddie? Thanks, Nathan. Good morning, everyone.

We generated a revenue of $19.9 million for the first quarter, which was up 18.9% over the same period last year, primarily due to lot rent increases and occupancy increases across the portfolio as well as acquisitions. Same community revenues of $18.6 million for the first quarter grew by approximately $1.8 million over the comparable period last year. This increase was driven by higher monthly lot rents, as well as growth in same community occupancy and increased utility revenues. Net operating income and NOI margin were $13.3 million and 67% respectively, compared to $11.1 million and 66.3% during the first quarter of 2023. Same community NOI margins for the first quarter were 67.8%, which was an increase over the same period last year. This increase demonstrates Flagship's ability to develop operational efficiencies the longer communities are owned by the REIT. AFFO adjusted, which does not take into account an infrequent mortgages settlement expense of $2.5 million we incurred this quarter, was $6 million, an increase of 16.8% from the first quarter of 2023. AFFO adjusted per unit for the first quarter of 2024 was approximately 29 cents, an increase of 9.6%. AFFO adjusted per unit for the first quarter of 2024 was approximately 33 cents, an increase of 9.1%. from the first quarter last year. Same community occupancy of 84.7% increased over the same period last year, which continues to reflect our commitment to resident satisfaction and ensuring our communities are desirable locations. Rent collections for the quarter were 99.7%, which demonstrates the strength and predictability of the MHC sector and was within our expectations. As at March 31, our total lot occupancy was 83.9%, and our average monthly lot rent was $447. Both of these metrics were within our expectations. We remain committed to preserving a conservative debt profile. Our weighted average mortgage term to maturity is 10.8 years, and our weighted average mortgage interest rate is 4.04%, as at March 31, 2024. We had total cash and cash equivalents of approximately $18 million, with an additional $10 million available on our line of credit. The REIT currently has 17 unencumbered investment properties with a total fair value of $33.2 million as at March 31, 2024. With that, I'll now turn it back over to Kurt for some final remarks.

Kurt? Thank you, Eddie. Our pending acquisitions and our refinancing measures have helped us get off to a great start in 2024. These initiatives, coupled by our solid operating and financial performance, position us well for the rest of the year. We believe we continue to be poised for growth as housing prices, high monthly rental rates and mortgage rate increases have made the potential to lead more people towards manufactured housing because our homes remain at an affordable price point. The majority of our residents have steady jobs or they are retired and receiving social security, disability or pensions. The interest rates of our customers have not changed substantially and their credit underwriting remains available. We ended up our quarter with rent collections also of 99.7%. We certainly thank you for your time today, and I will now open up the line for questions.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Mark Rothschild from Canaccord.

Thanks, and good morning, guys.

Good morning, Mark.

Hey, in regards to occupancy, since you've been public, you've had some good occupancy gains overall. I'm just curious with the cost of actually owning an MHC home having gone up, and I realize that the interest rates maybe not have gone up for MHC homeowners as for more traditional homes, but I'm just curious how this impacts the demand and ability of your tenants to actually purchase homes, and if this maybe will impact occupancy future occupancy growth from the core portfolio that you own?

I don't think it will negatively impact it. We just recently did some analysis. The affordability differential between us and the comparable housing alternatives in most markets still is $300 to $500 beneficial to live in our communities. You're going to save $300 to $500 more a month if you live in one of our communities. Still seems like people being driven to us because mortgage rates are high. Credit tightening on the stick build industry is also pushing people towards us. Frankly, when you get up, and that's normally that $300 to $500 range is normally for two and three bedroom homes. When you start talking about four and five bedroom homes, which we also sell, that affordability measure gets even stronger than $500 in savings a month for the customer. So I think right now we're in good shape. You know, the customers may move from double-wide to single-wide, if you will, or multi-section to single-section. But I don't think there's any headwind there that I'm worried about.

Okay, great. Thanks. And maybe just one more from me. The new acquisition, it might be too early for you to give some more information on this, but if you could just set up some timeline for expectations for actually getting the new homes on the vacant sites in this property and when you think you can actually have occupancy up there and have it really turn into being more accretive as far as a portfolio acquisition. And I realize that it

you have barely started or haven't even started yet so it might not be fair to ask at this point well i think we're closing next week so yeah we haven't we haven't started putting our inventory on but nathan you want to mark we have ordered our inventory and i think our inventory will take maybe four weeks to get there but we may get it even quicker um but you know we it's a new market for us we're already ahead of the game um on um getting our um license to sale manufactured house in there and it's a lengthy process, and I believe by the end of this week, we will have our license to sell manufactured housing in West Virginia. We already own a license in Tennessee, and we've already started that process, too, and I've already ordered houses for there. There are quite a few rental homes in some of those, and we will start dissecting those immediately that week. But I would say that you'll see some serious progress by the start of the first part of the third quarter.

In addition to that, Mark was asking about the accretion piece of it. The way we've modeled it currently, we expect sometime during the late part of year two to see accretion. What I'll tell you is I think that's a pretty conservative look at it and hopefully the worst-case scenario. There are some opportunities through home sales, through renting homes, and then some other cost-saving initiatives and revenue-driving initiatives that we could pull that forward and actually pull that into the later part of year one or even early year two.

Okay. And let me just follow up on this, and it might not be fair to ask at this point, but how many homes have you ordered and how many do you think you can add over the first year?

Well, four a month would be what we would probably try to add We will try to get more houses in during that time. And I don't find that getting houses is going to be a big issue. We will buy out of a separate plant than our normal plant, Mark, that you were at, through a plant probably out of Ohio that we'll bring to West Virginia. And then we'll be at our, obviously, our partner there in Benton, Champion Homes, will provide us our homes for the national location. And they have, and they're ready to gear up, they're gearing up building a few more homes a week to provide us with what we need there. You know, we're probably at least 30% to 40% of every home that goes down the line there at that factory comes to a flagship community property.

Okay, great. Thanks so much.

Thanks, Mark.

Thank you. One moment for our next question. Our next question comes from the line of Brad Sturges from Raymond James.

Hey, guys. Good morning.

Good morning, Brad. Just want to, I guess, follow on to Mark's question there, but go about it a little bit differently. Just thinking about CapEx or capital improvement spend, including, I guess, the acquisitions that are about to close. CapEx was about $5 million, I think, in Q1. How would you expect that to

uh trend over the next few quarters once uh you've got the new acquisitions completed yeah so the biggest part of the capex that we had budgeted for uh the new acquisition uh we threw out 10 million dollars of uh for capex in the budget the biggest majority of that about six million dollars we had originally scheduled for rental homes And we did that again. We go back to kind of budgeting in a conservative manner. But the thought process is that's the quickest way to drive occupancy there. So, you know, to Nathan's point, we've budgeted that we're going to get four of those houses a month at a couple other communities. So if you're getting eight houses a month, you know, we're at $50,000. You're doing $400,000 a month kind of early on now. There's a caveat there. And We believe that when we get there, we're not going to need all these rental homes, that we're really going to have a sales boom. The previous owners hadn't been selling houses, so we think we're really going to have some opportunity there, and maybe we don't spend as much of that capex early on as we thought. But also, the remaining $4 million, $4 to $5 million, that should be spent within the first 18 months of us owning the community in 24 months as we go in and do our amenity package, fix the streets, kind of the work there. What I tell you is for the remainder of the year, this is our CapEx season. CapEx season starts in kind of the early spring, and this is where we'll be paving roads and doing any of our new work. So we'll be buying less rental homes outside of that acquisition than we did in Q1, but we will have a good amount of work being done So, I would expect to see a considerable decline in gap expense in that sector.

Okay. That's quite helpful. Just to go back to the occupancy and just look at it more on a same-store basis, I think you've always guided for, I guess, 100 to 300 basis points of improvement each year. How do you think things are trending this year? relative to last year, and what would your expectations be for 2024 at this stage?

I think our expectations are about the same. You know, I think on average we'd like to be, you know, just north or just shy of 2% occupancy growth. It doesn't seem like there's anything standing in our way to do that other than making sure we serve the customers right now, get the houses in, get them sold, just like Eddie was talking, you know, The truth is, we not only want the occupancy, but we want quality occupancy. Quality occupancy is home ownership. Home ownership does happen in a lower increase on an annual basis, but it's sticky occupancy. It sticks around. We now have several locations that are in 95% and 100% occupancy range over the last three years. By buying this vacancy that Nathan just bought, that gives us essentially the room to do the true value-add work that we're really good at. So we're pretty happy with the occupancy quality that we're getting right now. And if we don't have to put those rental homes into this new acquisition, trust me, we won't. I mean, this is not something that we will put them in there if it's the right decision. And if we get in and start doing our normal home sales models, it could be even stronger in performance.

Okay. Last question. Just how has, again, not excluding the new acquisitions coming in, but just looking at the current portfolio, how has your – I think last year you had a pretty good year in terms of converting rental homes into owner-occupied residences. How is that trending this year? Do you expect that sort of similar trend to 2023?

We're right on plan. I think we've already converted 34. Yeah, we've converted 34. So again, last year I think we did about 150. And again, what happens is we do that a little stronger as we get into the second, third, and fourth quarter because people's tax refunds, their down payments, sometimes get a little smaller. So that means they need a cheaper use of pre-owned homes. So, yeah, I think we're right there. This market might lend itself to that exact question, by the way.

Okay, great. Thanks a lot. Appreciate it.

Thank you. One moment for our next question. Our next question comes from the line of Himanshu Gupta from Scotiabank.

Thank you, and good morning.

Good morning. Good morning.

So just on the lot rent growth of, I think, almost 7% in Q1, I mean, this is strong. Are you seeing pushback from tenants on these kind of rent increases?

Well, I think the answer to that, the short answer is no. You know, we're always really mindful of that, of that moment. The average rent increase was about $31, I think. And so you look at that and We're crazy mindful of rent increases. We actually do that review by location. We need to provide the best-in-class services for our residents. Unfortunately, inflation is real, and we had to raise the rent. We have stayed right on budget with occupancy, so I think at this point the answer is the rent increases have been absorbed. and our residents are stable and performing. The interesting thing is housing affordability. Again, that gap between $300 and $500, that's beyond real to my residents. This is the most affordable housing alternative, as you know, other than mom's couch. There you go.

Got it. Okay. So if I look at, you know, the rent growth of, let's say, 7% and occupancy growth of, let's say, 1% to 2%, so we could easily do, like, 10% plus same-store NOI growth? I mean, similar to what you did in Q1, like, for the full year?

Yeah, I mean, that is the... You know, we budget high single digits, kind of right at the low-level digits for same-queue NOI growth. Looking, you know... Considering that, we do have to think about the inflationary pressure that we still, at the first point, are getting. So, yeah, Q1 was good. There was some pickup in utility revenue that helped that versus prior year. But, yeah, I would expect high single digits to continue.

Got it. Okay. Thank you. And then just on the bridge loan, I mean, it looks obviously a bit expensive in the near term. When do you plan to put permanent financing on this piece, and what are the expectations for the rate on debt financing?

Yeah, so I mean, the expectation at this point is that within Q4 or maybe early Q1 of 2025, we'll have this refinanced with permanent financing. I don't know yet if that will be Agency debt, thank you for that'll be something we'd like to at this point. Still going through what fits best for these properties. What I will say is the expectation, if we did the debt today, it would probably be closer to 6%. There's some thought that maybe in Q4 we see some relief from an interest rate standpoint, which would kind of work with timing for us if we as we reposition a couple of these assets. And, you know, it's just getting a few of our things done, getting our playgrounds back. So, of course, the amenity packages into the communities and getting it ready for the private financing. So, like I said, I would see that by Q4, Q1 of next year, the latest we'll have private financing.

Got it. Thank you. Last question is on the acquisition portfolio. Just wondering, you know, what kind of stabilized cap rate did you underwrite on this acquisition, say, in year three? I mean, based on your NOI growth expectation for the next couple of years.

Yeah, so stabilized cap rate is going to be somewhere around seven and a half by year three. It's two and seven and a half and eight. You know, again, it really depends on how the occupancy drivers. Obviously, if we sell homes, like we hope to do, it could be better than that. The way we model it today with renting more homes as we talked lower, lower margin there that you know, the seven and a half is kind of where we expected to be.

Awesome. Thank you so much. And I will turn it back. Thanks.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Our next question comes from the line of Kyle Stanley from Desjardins.

Thanks. Morning, guys. Morning, Kyle. Good morning. Just two quick ones for me, but just on the acquisition, just be curious to kind of get your thoughts on what attracted you to West Virginia. Do you see, you know, a more significant opportunity to consolidate communities in that state and in similar markets in the future? You know, just curious on the thinking there.

Well, Kyle, we have always been interested in West Virginia. Sorry, though. But, you know, the thing about West Virginia is you need enough, when you go in there, you need an economy of scale to go there. interesting also we could be the first property in less than two hours from our office so West Virginia is extremely close location for us and we were able to go into the three real largest markets there and also it is not a consolidated state at all actually I don't know that any of the large companies are even there so it gives us an opportunity to go in and and find new partners there, people who are family shops that want to exit. And so we will continue the bolt-on strategy that we've used in other states. We're very happy with that. And then, obviously, the national location, we're only 45 minutes away. And then to the west, we're about an hour and 10 minutes away in Jackson. So it makes all the sense in the world for us to be there and to continue down and consolidate and find properties in the Tennessee market.

Yeah, no, that makes sense. Recreate the model that's worked well thus far. So that's good. Just second one, I'm sure this is the case, but, you know, in growing your NOI on the acquisition portfolio, I assume you'll be implementing the same kind of submetering systems that you have across the portfolio, just confirming that's the case. And do you have a sense on where kind of the utility recapture would be today on the portfolio and you know, where that could go, you know, anything to suggest that number can't get towards kind of where your total portfolio is running here today.

Yeah, the expectation, and we've actually already ordered the submeters. They are in route. We will have those kind of ready to start the process very early on. So the first answer is yes, but we will continue that. Today they're using a few of these locations are using a third-party provider that's doing their utility recapture. And while that is good and close to our normal recapture, call it the 80 to 85%, they're also paying a fee to do that. So we'll actually be doing it, and we believe we'll drive it closer. We budgeted it after the first year that we'll be up to 90% recapture for all of those communities. So, yes, I mean, there's some opportunity there. Again, the opportunity is to bring it in-house and for us to control ourselves.

Okay. That makes sense. Thanks for that. I will turn it back. Thanks, Seth.

Thank you. At this time, I would now like to turn the conference back over to Kurt Keeney for closing remarks.

Thank you, Operator, and thank everyone for participating today. Please feel free to reach out to our investor relations team at ir at flagshipcommunities.com if you have any further questions. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.